Notes on the speech by Benoît Cœuré of the ECB.
The crisis has made us understand that the size of the financial sector can exacerbate the trade-off between economic efficiency and financial stability. While finance per se is necessary for growth, an oversized financial industry can be detrimental to real economic activity. Of course, the question of what constitutes an “oversized” financial sector is a complex one...
I have written:
Would you wait until adding to total debt decreases GDP to say there is a harmful effect? Or would you say what I say: If adding to total debt produces a smaller increase in GDP than it formerly did, then harm has already been done.
The question is really not complex. If the next dollar of debt increases GDP less than the previous dollar did, then you are on the wrong side of the Laffer Limit:
If you watch an economy using credit for growth, using more credit increases growth up to a point; beyond the Laffer Limit it starts ruining the economy.
Benoît Cœuré:
As regards the link between finance and growth, for a long time, it was common to say that finance affects growth in a positive, monotonic way, as if more is always better. Recent empirical evidence, however, has qualified this conventional wisdom. The analysis has now been refined to show that, beyond a threshold size, the effect of finance on long-term economic growth can weaken and even become negative.
Yep.
Why is the effect of finance on growth non-linear?
Wrong question.
Cœuré, the banker:
In the wake of the financial crisis, the global regulatory architecture has evolved to meet the challenge posed by the financial sector’s potential to generate economic distress. For one, we have proceeded towards a more integrated governance of the banking sector in Europe. The first components of a genuine banking union – the Single Supervisory Mechanism and the Single Resolution Mechanism – are already being implemented. By aiming to make the banking activities conducted in Europe safer, the banking union implicitly touches on some of the aspects of “oversized finance” in general, and “overbanking” in particular...
We believe that we have learned our lesson...
The academic literature, as well as our own experience in the crisis, has proven that the size of the financial sector can exacerbate the trade-off between economic efficiency and financial stability. I hope that the regulatory reforms that are now being enacted and the recent changes in the European supervisory architecture, combined with the renewed push for a single market for capital in Europe, will go some way in addressing this trade-off.
We believe that we have learned our lesson...
The academic literature, as well as our own experience in the crisis, has proven that the size of the financial sector can exacerbate the trade-off between economic efficiency and financial stability. I hope that the regulatory reforms that are now being enacted and the recent changes in the European supervisory architecture, combined with the renewed push for a single market for capital in Europe, will go some way in addressing this trade-off.
No.
There is no "trade-off between economic efficiency and financial stability". If Benoît Cœuré thinks there is, then Benoît Cœuré fails to understand the Laffer Limit.
The banker's solution makes finance bigger. My solution makes finance smaller.
We must not allow bankers to design the future.
3 comments:
I dont remember the Laffer Limit. You probably talked about it somewhere but Im too lazy (and into my 2nd IPA) to look.
My guess though is that Mr Coueur'e is conflating public and private debt and he is calling for decreases in public debt...... so it doesn't crowd out private debt.
For bankers, the term finance means something different than it does for you and I. When we talk about finance, almost always we are talking about private banking. Bankers on the other hand include "public" finance, which I think is their focus.
Much of Coueur'es words seem to be in line with what I think, but I am inclined to believe that he wants nothing more than cuts to govt spending/debt and more private borrowing. IOW, more of the same neoliberal claptrap
IPA... I gotta put that on the shopping list.
Greg -- Benoit Coeure is not explicit, so you could be right. He could be concerned more with public than private debt. But he's talking about "the contribution of the financial sector to the real economy." He's talking about the real economy. So he seems to be concerned largely with private borrowing. That was my assumption, anyway.
My solution is to reduce finance. I don't expect a banker to think as I do. I think Benoit Coeure wants to expand finance. I think he just wants to find a "safe" way to do it.
The trouble is that finance imposes a cost on the real economy -- and the more you expand finance, the greater the cost. Trying to solve this problem, Benoit Coeure is wasting his time.
In his introduction, Coeure writes, "The crisis has made us understand that the size of the financial sector can exacerbate the trade-off between economic efficiency and financial stability." In his conclusion, he writes: "the size of the financial sector can exacerbate the trade-off between economic efficiency and financial stability." The size of the financial sector is most assuredly relevant. But Mr. Coeure misunderstands the relation between economic efficiency and financial stability.
More finance means more spending, but this is not the same as "economic efficiency". If he must focus on economic efficiency, then let us measure that efficiency in terms of debt productivity. As The Economist reports, "each additional dollar of debt was associated with less and less growth."
I think there was a period in the early years after World War Two when each additional dollar of debt was associated with more and more growth. But then that trend reached a peak -- a Laffer Limit -- and after that, we got less growth per dollar of additional debt.
Since we reached the Laffer Limit (in the late 1960s I'd guess) the "economic efficiency" of the financial sector has been in decline. This declining efficiency ultimately led to financial instability. Thus, Coeure is wrong to find a "trade-off" between financial efficiency and economic instability. It is the declining efficiency that created the instability. There is no trade-off there.
You are right he's not clear which he is talking about, and I don't mean to try and find the most uncharitable take on his views, but I'm pretty skeptical of most bankers these days. They are pretty wrapped up in the economic models which seem to only show benefits of rising private credit and prices while attributing any negative outcomes to public activity. Either by crowding out good investment opportunities or by downright theft through onerous regulations and taxation.
You don't have to convince me of negative role debt (private) is playing in our modern economy.
It seems there are two forces pulling in opposite directions and they are both being encouraged by TPTB.
Real economic activity is said to be too expensive so labor costs are driven down since that is the only factor these geniuses think affect prices, and financial activity is resisting deflation since it makes ALL past investments worthless.
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